Last week saw more evidence that U.S. economic growth is rebounding from the first quarter’s weather-induced contraction.
Favorable data showing improving growth – including a dramatic acceleration in jobs growth, a jump in pending home sales and a further rise in new manufacturing orders –fueled stock gains, helping the market kick off a strong start to the second half of the year.
Assuming the economic strength continues as I expect it to, a stronger economy is likely to impact the investment climate for both stocks and bonds in the second half of the year. To position portfolios for such an environment, investors may want to consider two moves in particular.
Adopt a cyclical bias in equities
As I’ve emphasized in recent weeks, though stocks aren’t cheap, I believe they can climb modestly higher in the second half amid continued economic improvement, and they continue to look more attractively priced than the alternatives. As such, I continue to favor stocks over bonds, though I believe a selective approach is key.
Within equities, I favor cyclical stocks — those most sensitive to economic growth — as they are likely to experience the biggest tailwind. Specifically, I see opportunities in energy and financials, as well as in select parts of the technology sector.
Avoid shorter-term bonds
The outlook for bonds largely depends on the length of their maturity. Last week’s data, combined with other recent employment indicators and some signs of higher inflation, may lead the Federal Reserve (Fed) to begin raising short-term interest rates. To the extent this occurs earlier than investors expect, shorter-term bonds –those with maturities between two and five years – are likely to be the most vulnerable, and could see their value fall.
Of course, while last week’s economic numbers are a hopeful sign that the economy is finally beginning to accelerate, how the stock and bond markets perform in the second half of the year – and, how the Fed reacts – all depend on this growth trend continuing.
Sources: BlackRock, Bloomberg
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Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.